In an important case for many Olim families, Esther Hayut, Chief Justice of the Supreme Court, has ruled again that Israeli taxes are immediately levied on a transfer of Israeli real estate by a Canadian couple to a trust for the benefit of their Israeli resident daughter (Galis Vs. Tel Aviv 1 Land Appreciation Tax Director, 5473/22 of January 3, 2023).

This judgement was the final stop in a series of appeals, including an earlier hearing in the Supreme Court.

Many had been waiting to see if Israel can get its act together in such cases. The problem is there are two acts – the Income Tax Ordinance which imposes capital gains tax (CGT) and the Real Estate Taxation Law which imposes Land Appreciation Tax (LAT) – a second capital gains tax with different rules for taxing Israeli real estate interests, especially when it comes to trusts.

Main facts of Galis case

In the Galis case, a Canadian resident couple settled an irrevocable discretionary Trust and transferred to it two Tel-Aviv apartments for the benefit of their granddaughter, an Israeli resident. The granddaughter did not know about the trust or that she was a beneficiary.

The Income Tax Ordinance says no Israeli tax applies on a transfer of assets to an Israeli Residents’ Trust for the benefit of Israeli Residents. But the Real Estate Taxation Law doesn’t say this.

The taxpayer argued that Section 3 of the Real Estate Taxation Law exempts transfers of real estate interests “to a trustee, guardian, liquidator or administrator pursuant to the Bankruptcy Ordinance” and certain other laws.

The Chief Justice and the ruled Supreme Court ruled that Section 3 does not apply to trustees generally of “contractual trusts”, only trustees pursuant to the bankruptcy law and other laws listed  in Section 3.  In addition, they ruled that the Income Tax Ordinance exemption expressly does not apply to Israeli real estate (ITO Section 75 Zayin (Daled) and Section 88 definition of “Asset”).

Instead, the real estate taxation law taxes a transfer of a right to Israeli real estate to anyone, including a trust and/or a trustee (RETL Section 1).

The Chief Justice and Supreme Court agreed with the Israeli Tax Authority’s Circular 3/2016 of August 9, 2016) which already pointed out the above.

Implications:

The Canadian couple, as seller, must pay Israeli land appreciation tax (25%-50%) on the Israeli property transfer to the trust, and the trust as purchaser must pay purchase tax of up to 10%.

If the Trust later sells the property, another dollop of Israeli tax will be due.

But if the trust distributes the property to a beneficiary, exemption from Israeli double taxation is possible if timely notifications are filed within 30 days of each act (RETL Secs 69 and 73).

Non-Israeli parties should also check the foreign tax situation. Can Israeli tax be credited at each stage?

The US-Israel tax treaty and other tax treaties do not help much. So maximum care is needed to avoid double or triple taxation. Even quadruple taxation is possible if any party is in business and liable to VAT….

A possible solution and a ruling:

The Chief Justice cited what Israeli Tax Authority (ITA) said: “There is nothing to stop taxpayers in future settling trusts defining specific designated beneficiaries whose identity is not open to change and who are aware ab initio that they are trust beneficiaries”. In other words, no more discretionary trusts, please.

Recently the ITA issued a tax ruling in this vein (3399/22 of August 9, 2022).

The ITA ruling explains that a trust need NOT exist and all taxes may be avoided on the transfer of Israeli real estate to a trust, if : (1) the transferor(s) are settlors and beneficiaries; (2) the transferor(s) retain material ownership of the apartments, even if ownership is registered in the name of the trustee, (3) if the trustee is serving merely as a “nominee/power of attorney holder”, (4) the Trustee does what the couple want as beneficiaries and has no discretion.

This amounts to a nomineeship or bare trust rather than a fully-fledged trust.

If the Trustee later sells the real estate, it is the transferor(s) who must report and pay tax on that sale, or the heirs must if they sell inherited real estate.

What can go wrong? If additions and changes to the beneficiaries are allowed in the trust agreement, transfers in and out the trust are taxable per the ITA ruling.

Next Steps:

Please contact us to discuss any of the above matters further, or any other matter.

As always, consult experienced legal and tax advisors in each country at an early stage in specific cases.

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(c) Leon Harris 6.2.2023